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COMMENTARY: ‘And now for something completely different’

Tom Webb.

Monday, Mar. 19, 2018, 11:21 AM

By Tom Webb Guest Contributor

First, I would like to thank AuSM and AuSM for providing me this platform to weigh in on various economic and industry trends. But why choose a “Monty Python” line as the title?

Because it is my hope this column will offer a differing perspective. Not to be a contrarian just for the sake of it, but rather to seek out areas where conventional “wisdom” becomes too lazily accepted. Consider the consensus theory on how the new- and used-vehicle markets will perform this year.

Used-vehicle sales will benefit as new-vehicle sales slow

Yes, there is little doubt that in unit terms new vehicles will likely decline, while used retail sales rise in 2018.

But it won’t be because of a substitution effect. In economist speak, new and used vehicles are complements; not substitutes.

For starters, consider the simple fact that most new-vehicle sales force one or more used-vehicle transactions within a matter of months. Trade-ins and turn-ins must be quickly retailed — and those sales often involve additional trade-ins and sales.

Yes, there is some substitution between new and used vehicles as the value proposition shifts over time, but that is swamped by underlying fundamentals.

Both markets are driven by the consumer’s willingness and ability to buy. And, in fact, the used-vehicle market is more sensitive to affordability and credit availability issues than is the new-vehicle market. Thus, it is ludicrous to argue that rising interest rates in 2018 will somehow help used-vehicle sales at the expense of new vehicles.

‘Want’ versus ‘need’

This misinterpretation between substitutes and complements is further exacerbated by a failure to understand basic market drivers. The “2018 Buyer Journey Study” from Cox Automotive notes that 61 percent of new- and used-vehicle buyers “needed” to buy, versus 39 percent who “wanted” to buy. (The percentage of need buyers was up from 56 percent in 2016.)

I suspect the survey respondents had a squishy definition of the term “need.” Sort of like when my granddaughter enters a store, and she says she needs candy.

The only people who “need” to enter into a vehicle transaction are those that have suffered a total vehicle loss, are end-of-term lessors, or are acquiring their first vehicle. Those categories combined are a small part of all transactions.

Most people buy vehicles because they have the ability and willingness to trade up. So, to be healthy, both the new- and used-vehicle marketplaces need income growth, credit availability and consumer confidence. Neither market ever “benefits” from deteriorating conditions within those forces.

The shifting value proposition

But, yes, the relative value proposition offered by the new- and used-vehicle markets does shift over time. And, as such, one market will perform better than the other. But that outperformance is a result of strength in that particular market’s dynamics — not the substitution effect between markets.

Price differentials between the markets can, of course, greatly impact the relative value proposition between a new- versus a used-vehicle purchase. The ratio of the new-vehicle CPI to the used-vehicle CPI has, however, stayed in a fairly narrow range for the past 35 years.

And, more importantly, there is no correlation between that series and the relative performance of new- and used-vehicle sales. Again, market fundamentals trump the substitution effect.

Bad theory, correct prediction. So what difference does it make if analysts get to the right forecast via a flawed theory? A lot, because dealers need to know who their used-vehicle buyers will be.

They will not be would-be new-vehicle buyers trading down, they will be used-vehicle buyers trading up. That’s especially true now that companies from Apple to Wal-Mart (and most in between) have given bonuses to rank-and-file workers as a windfall from tax reform. In addition, labor markets are just now showing some signs of wage growth for lower- and middle-income households. Those will the tailwinds in 2018. Ride them!

Tom Webb is the former chief economist for Cox Automotive, Manheim and NADA. He can be reached at [email protected] and on Twitter: @tomwebb1950.